Bernie needs to sew up a custom-fit plan

This hasn’t been a good week for Bernie Brookes or Myer. His merger target has been snatched from his grasp, he faces a far more formidable direct competitor and his own company now looks vulnerable.

The agreed bid by South Africa’s Woolworths for David Jones is potentially a game-changer in the traditionally lop-sided battle between the two big domestic department store groups. Myer is bigger and has been better managed than David Jones since the turnaround under Brookes that started during the group’s period of private equity ownership.

Strategically, with better systems, a much bigger sales base, the massive Myer One loyalty program with its more than five million members and, critically, more than 20 per cent of its sales coming from private labels, Myer was in a stronger position within a difficult market than David Jones.

Assuming the Woolworths’ bid for David Jones goes through smoothly – it is conceivable but unlikely that there could be a counter-bid or an on-market spoiler for the scheme of arrangement offer – David Jones will become part of the largest department store group in the southern hemisphere.

Woolworths’ Ian Moir is a first-rate retailer, understands the Australian market intimately and will leverage Woolworths’ existing private label strategy and scale to drive a David Jones private label strategy that today is virtually non-existent.

He has said he wants to lift the proportion of private label sales in David Jones from 3 per cent to more than 20 per cent within two or three years. The bulk of the $130 million of synergies in five years Woolworths’ anticipates from acquiring David Jones come from the margin expansion associated with the drive into private label.

Woolworths’ scale will give David Jones access to low-cost but fashionable products appropriate for the southern hemisphere seasons – a major issue for most of the northern hemisphere retailers now invading this market.

It is possible that Woolworths’ move on David Jones will cause some of the big international department store groups to take a closer look at Myer. The David Jones’ bid – nearly 40 per cent above the level at which David Jones shares were trading before Myer’s merger proposal became public knowledge – makes Myer look cheap.

Myer’s shares have fallen sharply since its half-yearly earnings report last month and, at $2.26, are trading nearly 20 per cent lower than they were ahead of that announcement of  lower earnings and a less-than-optimistic near term outlook.

Brookes and his board would be acutely conscious that a prospective uplift in Myer’s performance in 2014-15, as the big hump in its store refurbishment program subsides and the cost pressures flowing from the Fair Work Act’s impact on penalty rates and its own investment in its online platform stabilise, could make it even more vulnerable.

Given its existing strong position in private label and the comprehensive renovation of the group under Brookes, however, there isn’t the obvious and easy upside available to a prospective buyer of Myer that Moir can see within David Jones. Nor has Myer had the sort of governance issues that destabilised David Jones and made it so susceptible to a decent offer.

It is going to be fascinating to see how Brookes responds to the threat posed by Woolworths’ probable entry to his market.

He’s already pushing the private label strategy but it is possible that might become slightly more aggressive. It is also conceivable that Myer might look more aggressively at acquisitions of its own, with the Sass & Bide acquisition demonstrating that it can manage other brands.

There isn’t, however, now that David Jones appears out of reach, another obvious "Big Bang" transforming acquisition available to Myer.

Brookes would no doubt have seen and be thinking through the implications of Moir’s comments on how David Jones would be positioned under Woolworths and, in particular, his plans to abandon the “House of Brands” strategy David Jones has pursued in favour of the private label strategy.

David Jones targets a narrower range of customers than Myer, with a focus on premium segments of the market whereas Myer, while competing head-on with David Jones in that segment, has a brand architecture that spans a much broader demographic range.

If David Jones were seen by its customers to be drifting down-market, that might create a bigger opportunity for Myer – although the invasion of high-end retailers from offshore means that space is being increasingly contested.

Both Myer and David Jones were facing stronger competition from the international retailers pouring into the market and from the continuing growth of online retailing within a retail environment that remains subdued.

Woolworths and its conviction that it can significantly more than double David Jones’ earnings within five years via the private label strategy gives David Jones a safety valve. Brookes may now have to search harder and more creatively for one of his own.